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Animation house loses EIS tribunal appeal
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EIS: Pyrrhic victory for HMRC

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A tax tribunal found that an animation production company was trading, but not a on commercial basis with a view to profit, as required to issue compliance certificates under the Enterprise Investment Scheme (EIS).

14th Dec 2021
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A tax tribunal found that an animation production company was trading, but not a on commercial basis with a view to profit, as required to issue compliance certificates under the Enterprise Investment Scheme (EIS).

The company CHF PIP! had previously issued EIS qualifying shares and submitted two EIS1 compliance statements for new share issues issued between May and November 2018. HMRC rejected these, and the company’s appeal was dismissed by the first tier tribunal (FTT).

Background

CHF PIP! had traded since July 2015, but had never reported a profit. It had previously issued EIS shares. The investment memorandum published prior to the 2018 share issues projected a rosy future for the company and CHF PIP! was successful in raising capital on the basis that EIS relief might be available.

HMRC’s case

By 2018, it was evident that all of CHF PIP!’s activities were carried out by subcontractors -specifically, companies which were connected to other CHF companies. This led HMRC to contend that CHF PIP! was not, itself, trading, but was carrying on an investment activity of financing. 

Additionally, as the creation of the intellectual property (IP) which CHF PIP! would go on to exploit had been subcontracted out, HMRC contended that even if CHF PIP! was trading, it was carrying on an excluded activity, as it had not created the greater part of the value of the IP itself. 

A further contention was that the company did not meet the risk to capital requirement, in that it had no plans to grow and develop itself – as with the activity. HMRC argued that all of the growth and development was within the CHF group companies to which the activity was subcontracted.

Risk to capital requirement

This is an over-arching piece of EIS legislation (also relevant for SEIS and VCT).  The requirement (s157A ITA 2007) is in two parts. There must be a risk to the capital of the investors in the company, as you would expect from the name, and indeed, the company is now in administration, having failed. However, the company must also have “objectives to grow and develop its trade in the long term” and it was on this point that the appeal failed.

The reason the FTT reached this conclusion is unusual, in that it was a subjective decision.

The FTT did not accept the company’s turnover and profit projections as evidence that the company intended to make a profit. In doing so, the FTT was supported by the decision in Ingenious Games vs HMRC [2021] EWCA Civ 1180, which is clear that there must be a genuine subjective view to a profit.

The FTT’s view was that there was no evidence to support the turnover and profits in the company’s financial forecasts, and no evidence was given to the FTT regarding the company’s officers’ intention to make a profit. In the Judge’s words, the turnover and profit projections were “spectacularly optimistic” and “wholly unrealistic” -  a pretty damning verdict, it has to be said.

However, it must be seen in context.  This case was not helped by the absence of witnesses for the company, partly due, I expect, to the fact that it is now in administration. For that reason, I would be surprised if an appeal were brought. 

It is clear from the judgement that companies should ensure that they can support the figures put forward in their financial forecasts with detailed explanations and backing. I hope, though, that HMRC does not read this judgement as giving it the green light to examine every prospective EIS company’s financial forecast in depth because any forecast by its nature is not precise but a company’s best prediction of what might happen in the future.

Conclusions

I’ve called this a pyrrhic victory for HMRC, because, although the tax department won, the FTT made some key findings in that it:

  • Reaffirmed that a company which subcontracts its activity is trading itself
  • Confirmed that IP created by a subcontractor is owned by the company; and
  • Confirmed that, in itself, subcontracting does not breach the risk to capital requirements.

Importantly, the CHF PIP! decision confirms that the existence of one or more of the circumstances listed in ITA 2007 s157A (3) does not necessarily mean that the risk to capital condition has been breached. 

There is no relationship between the author, and the Mr Charles Ward who gave evidence to the Tribunal.

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By Justin Bryant
15th Dec 2021 09:53

You do see bizarre submissions from HMRC from time to time and it is wholly unmeritorious and quite frankly ridiculous nonsense to argue that using agents and the like causes companies not to have trading activities as it is very well established law that a principal acts through their agent(s).

The 2nd bullet point above is trite law also.

So it's not particularly Pyrrhic in that context.

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